IS IT CORRECT ! Frank White will retire in three years. He wants to open some ty

Question

IS IT CORRECT !

Frank White will retire in three years. He wants to open some type of small business operation that can be managed in the free time he has available from his regular occupation, but that can be closed easily when he retires. He is considering several investment alternatives, one of which is to open a laundromat. After careful study, Mr. White has determined the following: Washers, dryers, and other equipment needed to open the laundromat would cost $176,000. In addition, $5,000 in working capital would be required to purchase an inventory of soap, bleaches, and related items and to provide change for change machines. (The soap, bleaches, and related items would be sold to customers at cost.) After three years, the working capital would be released for investment elsewhere. The laundromat would charge $1.35 per use for the washers and $0.60 per use for the dryers. Mr. White expects the laundromat to gross $3,780 each week from the washers and $1,860 each week from the dryers. The only variable costs in the laundromat would be 7 1/2 cents per use for water and electricity for the washers and 9 cents per use for gas and electricity for the dryers. Fixed costs would be $4,900 per month for rent, $3,400 per month for cleaning, and $2,065 per month for maintenance, insurance, and other items. The equipment would have a 12% disposal value in three years. Mr. White will not open the laundromat unless it provides at least a 13% return. (Ignore income taxes.) Click here to view Exhibit 13B-1 and Exhibit 13B-2. to determine the appropriate discount factor(s) using tables. Required: Assuming that the laundromat would be open 52 weeks a year, compute the expected annual net cash receipts from its operation (gross cash receipts less cash disbursements). (Do not include the cost of the equipment, the working capital, or the salvage values in these computations.) Determine the net present value using the net present value method of investment analysis. Would you advise Mr. White to open the laundromat Yes No

Explanation / Answer

The correct answers are as follows:

1. variable cost for washers = 3780*0.075/1.35 = $210 per week
Variable cost for dryers = 1,860*0.09/0.6 = $279 per week
Annual net cash receipts = [(3780 + 1860 - 210 - 279)*52] - [(4900 + 3400 + 2065)*12] = $143,472

2. Terminal Cash Inflows = (176000*12%) + 5000 = $26,120
NPV = Present value of cash inflows - present value of cash outflows
Present value of cash inflows = 143,472 x PVAF(13%, 3years) + 26,120 x PVAF(13%, 3years) = (143,472 x 2.361) + (26,120 x 0.693) = $356,861.76
Present value of cash outflows = 176,000 + 5,000 = $181,000
NPV = 356,861.76 - 181,000 = $175,861.76

3. YES, because the NPV is positive.

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